“Unless, of course, Congress Acts”

Oral arguments in South Dakota v. Wayfair, Inc. were fast-tracked by the Supreme Court to April 17, 2018.^[1]  Enjoy the calm before the storm. 

Most nexus discussions related to Wayfair center around sales tax imposed on tangible goods ordered on the internet from remote sellers versus tangible goods purchased at brick-and-mortar, in-state stores. However, many remote sellers also sell services.  How will overturning the physical nexus standard impact the service providers?

Spending on services accounts for 47 percent of gross domestic product and of that amount, 6.5 percent is attributable to the digital economy.^[2],[3] Existing laws for prewritten software are generally used in asserting sales tax on digital services other than those specific to digital equivalents (e.g. eBooks). Usually, the digital service is deemed to be some sort of software which, in turn, is considered tangible personal property (TPP). TPP is defined as anything you can see, weigh, measure, touch or is otherwise perceptible to the senses. 

The tax is imposed where the service is received, accessed and/or where the benefit of the service is derived. Twenty-six states impose sales tax on digital products,^[4] sixteen states impose tax on software as a service,^[5] and twelve states impose tax on information services.^[6] Remote service providers whose sole contact with the state is delivery of services over the internet currently do not have physical nexus in most states.^[7] Therefore, if the service is a taxable service, the buyer is obligated to accrue a use tax and remit it to the state.

Taxable service types in various states include: (a) services associated with the sale of tangible personal property (e.g. delivery services); (b) services requiring some form of hardware to facilitate the service (e.g. internet of things, security); (c) a digital equivalent to a physical service (i.e. streaming video or satellite TV); (d) a digital equivalent to tangible property (e.g. e-Books); (e) the compilation of data into a report (e.g. market analysis, credit reports); (f) amusement or entertainment services (e.g. online games); (g) a computer service (e.g. tech support); and/or (h) any user-accessed internet service that may use technology on a regular basis especially if the pricing model is subscription based. All the discrete apps, services or tools which form the fundamental components and enable search engine optimization, artificial intelligence, machine-learning, cryptographic applications, predictive analytics, bots or virtual reality may also become subject to tax under this definition if nexus is established. Unlike manufacturing, there are no legal exemptions for the “raw materials” of taxable services, so the result is a pyramiding of the sales tax for the taxable service provider.^[8],[9]

These primary and underlying services generate revenue and that revenue will create nexus if Quill’s physical standard is overturned by Wayfair. Once nexus is created, these service providers share an equivalent or greater tax risk with physical goods sellers because service providers may not know geographically where or to whom their service is provided, especially if paid by credit card. The states can assert taxability using their broad tangible personal property or taxable service definitions, while the service provider carries the burden to prove otherwise. This puts the service provider at a distinct disadvantage to any state that asserts situs and seeks to impose its tax. Thus far, these service providers have not had to get into a taxability argument since their lack of physical presence made that argument moot.  However, if Wayfair overturns Quill, their last line of defense is gone.  Without clarity, we will likely reenter a similar chaotic period of uncertainty like that we had after Bellas Hess,^[10] but before Quill.^[11],[12]  Unless, of course, Congress acts.

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[1] On January 12, 2018, the Supreme Court granted South Dakota’s petition for a Writ of Certiorari in its case against Wayfair, Inc., Overstock.com Inc. and Newegg Inc. (South Dakota v. Wayfair, Inc., Overstock.com Inc. and Newegg Inc. Supreme Court of South Dakota, September 13, 2017).
[2] Ibid.
[3] “How Big is the Digital Economy?” Bureau of Economic Analysis, accessed March 26, 2018, https://www.bea.gov/digital-economy/_pdf/infographic-how-big-is-the-digital-economy.pdf. Data includes computer hardware and software, telecommunications services, margins on retail e-commerce transactions, and subscriptions to online streaming services, but excludes other components of the digital economy such as peer-to-peer e-commerce. (e.g. ride-sharing services).
[4] AL, AZ, CO, CT, DC, Hawaii, Idaho, IN, KY, LA, Maine, MN, MS, NE, NJ, NM, NC, Ohio, SD, TN, Texas, Utah, VT, WA, WI, WY (conditions apply- check each state’s tax regulations and code).            
[5] AZ, CT, District of Columbia, Hawaii, MA, NM, NY, Ohio, PA, SC, SD, TN, Texas, Utah, WA, WV (conditions apply- check each state’s tax regulations and code).
[6] District of Columbia, FL, Hawaii, NJ, NM, NY, Ohio, SC, SD, Texas, WA, WV (conditions apply - check each state’s tax regulations and code).
[7] Certain states have enacted Remote Seller statutes which impose a sales tax if the user accesses a web site from that state.  These statutes are questionable under physical nexus standards but have not thus far been successfully challenged.
[8] “Resale of services” exemptions do exist but only if the service is sold intact.
[9] For example, a service provider pays $100 each for three components ($300) and pays $30 in sales tax.  The service provider then sells the taxable service for $600 and charges $60 in tax.  The state “pyramids” the tax by getting $30 for the first transaction and $60 for the second transaction.
[10] Bellas Hess, 386 U.S. at 763 (Fortas, J., dissenting).
[11] Ibid. 6.
[12] See previous blog post “History Repeats Itself” (February 22, 2018).